1. Field of the Invention
The invention is in the field of financial management and more specifically in the field of loan management.
2. Background Art
Lending is an integral part of modern financial markets. Loans are typically made under contact for fixed or variable interest rates. For example, a home loan may have a term of 30 years at a fixed interest rate. In this case, the loan represents a stream of payments to the lender and is thus an asset whose value is easily calculable and typically marketable on secondary markets. The value of this asset may change over time with changes in interest rates, interest rate volatility, or other factors. Thus, if interest rates rise the value of the loan to the party receiving payments may decline, and if interest rates fall the value of the loan to the party receiving payments may rise.
Historically, loan contracts have either allowed prepayment (of some or all of an outstanding loan balance) without a prepayment fee, or with a fee specified in a prepayment fee schedule. When the value of a loan has risen from the lender's perspective, prepayment is to the disadvantage of the lender. Prepayment fees are designed to compensate for this disadvantage, among other things. When the value of a loan has fallen prepayment is to the advantage of the lender because, presumably, the lender can then re-lend the prepaid funds at a higher interest rate, or otherwise benefit from making a new loan. Thus, prepayment under these conditions may be a benefit to the lender above what would normally be required to make the lender financially indifferent.
As interest rates and other financial variables change, the value of prepayments to the lender, change as well. However, the value of prepayments to the borrower does not change in the same manner. For example, if interest rates rise and a prepayment is made then the lender may receive a benefit. However, there are no mechanisms by which the borrower may share in this benefit. Barring outside factors, there is, therefore, little incentive within prior art loan contracts for the borrower to make prepayments under certain circumstances. This lack of symmetry in benefits (and harm) associated with prepayments represents an inefficiency in the financial markets.
Elimination of this inefficiency would be beneficial to both lenders and borrowers. Any solution, however, should fit within limitations imposed by accounting regulations.